October 17, 2016

WSJ: Everyone’s Worst Investing Fears

Snapchat is not about to disappear—this newspaper reported earlier this month that the firm may go public next year with a $25 billion valuation. Don’t you wish you had invested at a $500 million value? Lots of investors underwater this year sure do.

Last month Perry Capital, which peaked with $15 billion under management in 2007, closed its flagship fund. Richard Perry, a Robert Rubin protégé, complained in a recent letter to investors that “this market environment has not worked well for us.” Really? The Dow is now within a hair of its all-time high.

Some 10,000 hedge funds invest almost $3 trillion. More funds closed than opened over the last year. With $20 billion in assets, Lansdowne Partners is down almost 15% this year. The Rhode Island State Investment Commission is cutting hedge-fund holdings by half, following Calpers dropping hedge funds altogether last year. What’s going on? This isn’t a nasty bear market.

So many asset classes are in a funk. Macro investing, making bets based on major geopolitical trends, was all the rage over the last 25 years. But George Soros breaking the Bank of England is a thing of the past. Debt is now monetized rather than rationalized. There is a glut of commodities—from forests to food. Energy is fracked. Private equity probably peaked a few years ago, but it hasn’t yet marked to market. And bonds? When you have to pay Germany to own its sovereign bonds, it is tough to make money. That leaves stocks.

Equity investors have loved lower interest rates, because they make stocks more attractive than bonds and increase the value of future earnings. But at zero and even negative interest rates, it is a mess. Think of zero rates as a compass that can’t point north and only spins around. Dividend-discount models to value stocks are driven by a discount rate that at zero makes every stock worth infinity. So stocks look cheap, even though they’ve never been more expensive.

What to do? The first rule of investing, unlike Fight Club, is that there are no rules. Investing is like fashion. What’s hot and what’s not changes at the whim of the market. It used to be every fund owned Apple, until it stopped working. Right now we are in what CNBC’s Jim Cramer calls a Fang market, because of the power of Facebook, Amazon, Netflix and Google. Google has done the worst of the bunch since January 2015—up only 50%. Netflix and Amazon have both doubled. In an economy with 2% GDP growth, not much else works.

Tomorrow’s fashion? If I knew for sure, I’d be on a Bora Bora beach. But I can point to the right neighborhood. It’s the New over the Old. New productive companies destroying the old ways of doing business.

The market does the dirty work, providing access to capital for those it thinks will be the next wave of great companies. It starves those in decline. This is why BlackBerry doesn’t make phones and why General Motors is throwing good money after bad into technology and partners for autonomous vehicles. SoFi is hurting banks.

But even being the New can be fleeting. Apple’s iTunes stung music companies by offering reasonably priced songs instead of full albums. And now streaming companies like Spotify offer unlimited music for $10 a month. The Newer destroying the New. I call this Lily Pad investing: You’ve got to hop from one company to another before the first one drowns. But it’s hard.

Finding the next wave of hot companies can be a pain in the assets. The minor leagues for this crop of the New is often venture capital. The New firms are then swallowed up by public investors during initial public offerings. Yet companies are staying private much longer. There is no public market for SoFi or Spotify. Thanks to “financial reform” acts like Sarbanes-Oxley and Dodd-Frank, the market for IPOs has been a ghost town.

Trillions in assets are itching to invest in these markets, but for now investors are stuck with firms that are under attack. Try to find investment in virtual reality, genome editing, drones, voice-control interfaces, artificial intelligence, chatbots or robots. Even immunotherapy and gene-therapy investments are far and few between. These companies become billion-dollar unicorns because they stay private. And not all of them will work. Hyperloop is aptly named.

Just recently, the IPO window has cracked open in a small way. Nutanix—an integrator of servers and storage that hopes to destroy Hewlett-Packard, IBM and Dell EMC—saw its stock almost triple in the first few days of trading last week. Earlier IPOs would sure be nice.

The king of the New, Uber founder Travis Kalanick, remarked at a German technology conference this summer, “I say we are going to IPO as late as humanly possible. It’ll be one day before my employees and significant others come to my office with pitchforks and torches. We will IPO the day before that. Do you get it?” And that tells you why so many are showing such runty returns.